Changes to Europe's capital adequacy regulation and associated stress testing regimen—also echoed in issues with US CCAR testing—need clarifications
If Basel III already has the industry quivering like a dog cowed by an invisible electric fence—as NYU professor Brad Hintz described it during a panel discussion hosted by Broadridge this week, around the release of its industry survey—what's it going to do if a tougher "Basel IV" comes along?
First of all, it's strange and confusing that Mark Carney, chair of the Financial Stability Board (FSB) and a governor of the Bank of England, is weighing in publicly about tightening risk modeling and capital assessment rules, which are part of Basel III—since the FSB isn't the architect or administrator of Basel III. The Basel Committee on Banking Supervision (BCBS) is the body responsible for that set of rules. We should be asking BCBS if they are thinking about a "Basel IV."
All that aside, the changes being made to Basel III are "pretty radical," as Hintz characterizes them. "European banks face some real issues with their risk weightings. If you adjust risk weightings, it's going to change inventory positions and your ability to hold legacy positions and work them out over time," he says. The result, according to Hintz, is that firms must offer a "smorgasbord of every product to everyone, all the time."
While capital adequacy and stress testing appear to be getting tougher in Europe, they may be getting easier in the US, if the US Federal Reserve removes, at the industry's urging, its assumption in CCAR testing that firms would continue dividends and stock buybacks even in a severe economic downturn. "From the Fed's perspective, it wants to use CCAR correctly, and that means they have to keep it opaque," says Hintz. The question then would be whether CCAR's requirements are so secretive or impenetrable that financial firms having difficulty completing the tests have a valid excuse as a result.
CCAR has been in place for a few years now, but its specifics change each year. BCBS 239, its European equivalent—and also the stress testing regiment carrying out Basel III's principles—is about to see its first run in 2016 (see my July column on industry readiness).
To know how to organize, process and report data to complete these tests and comply with these regulations depends on clarity about what the rules are and specificity about how they are being updated. In the present climate, it's questionable whether that's available. Before regulators can start a "Basel IV," they should tie up the loose ends still hanging off Basel III.
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